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Dollar Tree, Inc. (NASDAQ:DLTR)

F1Q08 Earnings Call

May 28, 2008  9:00 am ET

Executives

Tim Reid – Vice President Investor Relations

Bob Sasser – President, Chief Executive Officer

Katy Mallas – Vice President, Controller

Analysts

Mitchell Kaiser - Piper Jaffray

Adrianne Shapira - Goldman Sachs

Karen Short - Friedman, Billings, Ramsey & Co.

Meredith Adler - Lehman Brothers

David Mann - Johnson Rice & Company

Michael Baker - Deutsche Bank Securities

Patrick Mckeever - Mkm Partners LLC

Charles Grom - J.P. Morgan

Joe Feldman - Telsey Advisory

John Zolidis - Buckingham Research

William Keller - Ftn Midwest Securities Corp.

Operator

Good day and welcome to the Dollar Tree, Inc. first quarter 2008 earnings release. (Operator Instructions)

At this time, I would like to turn the call over to Tim Reid, Vice President of Investor Relations. Please go ahead, sir.

Tim Reid

Thank you, [Cindy]. Good morning and welcome to the Dollar Tree conference call for the first quarter of fiscal 2008. My name is Time Reid. I'm Vice President of Investor Relations.

Our call today will be led by Bob Sasser, our President and Chief Executive Officer, who will provide insights on our performance in the quarter and recent developments in our business. Katy Mallas, Vice President, Controller, will provide a more detailed review of our first quarter financial performance and provide our guidance for the second quarter and full fiscal year 2008.

Before we begin I would like to remind everyone that various remarks that we will make about future expectations, plans and prospects for the company constitute forward-looking statements for the purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors included in our most recent press release, most recent current report on Form 8-K, quarterly report on Form 10-Q, and annual report on Form 10-K, all of which are on file with the SEC. We have no obligation to update our forward-looking statements, and you should not expect us to do so.

At the end of our planned remarks we'll open the call to your questions, which we ask that you limit to one question and one follow-up question, if necessary.

Now I'd like to turn the call over to Bob Sasser. Bob?

Bob Sasser

Thank you, Tim. Good morning, everyone.

This morning we announced earnings for the first quarter of $0.48 per diluted share. That represents a 26.3% increase over last year's $0.38 per diluted share.

As previously announced, total sales for the quarter were $1.051 billion, an increase of 7.8% over the first quarter of fiscal 2007.

Comp store sales increased 2.1% for the quarter on top of a 5.8% increase last year and a 4% increase the year before. Our comparable store sales increase was the result of a 2% increase in traffic and a small increase in transaction size.

These results were accomplished despite an earlier Easter, which we believe cost us about $15 to $20 million of lost volume compared to the fiscal 2007.

Obviously, I'm very pleased with these results. We've been operating in a very challenging environment, with consumers facing a lot of pressure from record high fuel prices and general economic uncertainty. But for Dollar Tree in the first quarter that translated into increased demand for basic consumable products. Customers relied more than ever on Dollar Tree for great value in food and household consumables as well as health and beauty care basics.

As most of you know, one of our key initiatives over the past few years has been to increase the selection of consumer basics to our merchandise mix, and we're now getting credit from our customers for doing this. We've added more of the things that people need every day and that are more frequently purchased. For many customers, we've become a destination for categories such as basic cleaning supplies, health and beauty care and a variety of consumer basics, things that people need every day.

These are some of our fastest growing categories and we continue to improve our product assortment and our value. Using improved replenishment methods, we're providing a better in stock position on these basic products. That's important also to our customers, who are under pressure from high gasoline prices and energy costs. They're now finding more of the things they need every day, and it's giving more customers more reason to shop Dollar Tree more frequently.

Additionally, we've continued our expansion of frozen and refrigerated product to more stores, and during the first quarter, for example, we added freezers and coolers to 84 Dollar Tree stores. That's on track with our goal to add freezers and coolers to 150 stores for the full year. At the end of the first quarter this year we had freezers and coolers in 1,058 stores. That compares to 742 stores at the same time last year, or plus 316 stores than the same time last year.

In addition to basic everyday items, our party and seasonal businesses drove sales, energy and merchandise excitement throughout the quarter. These are businesses that we've always been very proud of, excited about, our customers know us for. Beginning with Valentine's Day, our seasonal business was strong, with credit going to the merchants for an exciting assortment and to the stores for a quick transition and impactful presentation.

Valentine's Day, by the way, continues to grow in importance for Dollar Tree and was successful again this year. Part of our success in overcoming the effects of an early Easter was due to the growth of our Valentine's Day business. It's a fun and colorful holiday for our stores and they found ways to make it a special event for our customers. Stores were stocked with helium balloons and Valentine's candy, bath and spa products to fill gift baskets, and of course cards and gift bags and wrapping paper; even long-stemmed roses, both artificial and real, for only $1. As a result, you couldn't go into the store without buying something for your special Valentine.

Valentine's Day sales efforts were supported with special signing and an in-store flyer this year. This was new for this year. The value was more relevant than ever, and our customers responded positively and we had a good sell through.

As we all know, the extraordinarily early Easter presented a major challenge. Based on history we had anticipated a $25 million shortfall as the result of a nearly two-week shorter Easter selling season. Our merchants, marketing and store teams met this challenge head on and with several key initiatives, we were successful in offsetting the sales shortfall.

First of all, with product, the value was terrific. The Easter product was fresh, and our stores transitioned very aggressively into the Easter product set.

Secondly, using our improved planning and allocation tools, our allocations and replenishment team focused on maximizing sales at our highest potential stores and continued to improve allocations overall. This is a learning process that we've gone through here.

And third, we were successful in driving more sales through marketing and promotion. We added more markets to our preEaster insert which ran on March 9 in 49 warm weather markets covering about 1,300 stores. It was actually 1,361 stores. This was against 17 markets and approximately 600 stores last year. Additionally, we ran an insert on April 13 this year to help drive post-Easter sales. This tab was new and ran in 21 markets, covering 1,000 stores, and it focused on our Luau Party promotion, our Candy Carnival and our spring cleaning product.

In our business, it's always about merchandise and especially new product, and the first quarter was no exception. In addition to the Easter seasonal product there was a constant flow of new general merchandise. Our floral business continues to thrill our customers and has outpaced company sales at very healthy margins. I'm extremely proud of our floral business and what our merchandise manager's done with that. It's really come up several notches, and it's paying off right now. Our customers are loving it, too.

Driven by luau and summer themes, our party business continues to offer values second to none. And as those of you who shop our stores know, there's always something new at Dollar Tree and always at a great value. That's the key differentiating factor for us and a strategy that has worked particularly well this year. We believe this continuous flow of fresh product and great values keeps our customers coming back, especially now with added pressure on consumers to get the most value for their dollars.

In addition to the merchandise initiatives, as you know we have over the past several months expanded our tender [type] acceptance. And when I speak to payment types and tender types, I'm referring to three things. First, our debit card rollout - the penetration of debit card usage continues to increase in first quarter. Additionally, we saw a lift from our Visa credit in the first quarter. We rolled that out last year, October 31. We expect the penetration of Visa credit to continue increasing throughout 2008. And we currently accept food stamps in 1,250 qualified stores, and this number is growing.

And talking about new store growth, during the first quarter this year we opened 83 new stores and relocated and expanded another 24 stores. And we grew our total square footage about 8%. Our targeted size range remains 10,000 to 12,000 square feet. Last year we averaged squarely in the middle, around 11,000 square feet on new stores, and the 2008 class is running about the same. It may be just a shade below 11,000, but it's right still in the middle of our 10,000 to 12,000 range.

We ended the quarter with 3,474 stores and room to grow. We plan to open 225 to 245 new Dollar Tree stores, 25 to 30 new Deals stores, and expand and remodel 90 to 100 stores this year. Over the longer term, we believe we can operate 5,000 to 7,000 Dollar Tree stores across the country, and our deal's multi price point concept has the potential of expanding that number.

Speaking of Deals, as most of you know we're using our Deals stores as a platform to develop an additional format, lifting the restriction of the $1 price point to offer even more value and convenience while leveraging the strength and infrastructure of Dollar Tree.

The key elements of a Deals store are surprising value and convenience and a fun and friendly shopping experience. They're largely focused at the $5 price point and less. Customer acceptance of the concept has been good. We're especially excited over the availability of new merchandise opportunities at the higher prices and the lift that it gives us in our average ticket in those stores. We've expanded the concept now into new regions with very good early results. We opened 11 new Deals stores in the first quarter and are well on our way to our goal of 25 to 30 new Deals stores for the year.

These new Deals stores are the best test of our concept, and so far the results are encouraging. In the first quarter the new Deals stores continued to outperform the original stores by nearly every sales metric, including average ticket and percent of purchases, including items over $1. This is consistent with our experience from the fourth quarter last year as well as our expectation.

Our greatest opportunity lies in the rationalization of the merchandise mix. That's going to require continued hard work and focus, and toward that goal we've strengthened our Deals leadership. During the first quarter we recruited Allan Goldman into the new position of Senior Vice President of Deals stores. He's an experienced retailer and comes to us with a strong background in merchandising. He's be responsible for the overall execution of the Deals strategy and the growth of the concept, enabling Mike Saltzer to focus full time on leading the merchandise organization and refining the merchandise assortments and creating merchandise excitement.

We're more excited than ever about the Deals concept. We believe Deals fills a unique niche in the value retail segment. It offers an opportunity to serve even more customers in more markets. We'll continue to roll out new stores in a measured and thoughtful way as we refine these operating metrics, and we'll update you as we progress.

Just a comment on share repurchase. I want to comment just briefly on that. Dollar Tree is committed to building value for our long-term shareholders and share repurchase has been a part of that equation. Last year alone we repurchased more than 12.8 million shares or $473 million worth of our stock without increasing our long-term debt. This reduced our cash balance substantially at year end 2007.

This year, first quarter, we decided to conserve cash and did not buyback any stock. We currently have $454 million remaining in our authorization. And has been our practice, we'll continue to review share repurchase opportunistically and we'll update you on additional share repurchase at the end of the quarter in which they may occur.

Now I'd like to turn the call over to Katy Mallas, our Vice President and Controller, who'll give you more detail on these and other financial metrics in the first quarter and provide guidance for second quarter and for the year. I'll then provide some summary comments, and we'll answer any questions you may have.

But before I do that, I want to say a couple of things. You may be curious to know where we stand on our CFO search. We are deep in the process of identifying and interviewing and assessing qualified candidates. I'm looking for, first of all, technical skills and financial acumen, secondly, a fit with our culture and an enthusiasm for our business, and third, strong leadership skills. I'm being very diligent in the search to get the right person for this job, and I'm able to do so, even if it takes a little longer, because we have a tremendously talented finance team in place. So be patient with me on this. We'll get the right person, and meanwhile things are running very smoothly in our Finance Department. I have great confidence in them.

Katy, it's all yours.

Katy Mallas

Thank you very much, Bob. Good morning, everyone.

As Bob mentioned, our earnings per share increased 26.3% in the first quarter. This increase was driven by a 50 basis point improvement in gross margin to 33.9% from 33.4% in the first quarter last year. Two main factors contributed to this performance improvement. First, we had improved merchandise margin driven by continued improvements in our sourcing. Second, our shrink rate for the quarter was lower than last year. This is the result of an intense focus for more than a year by Operations and Loss Prevention, including additional training and new procedures to minimize shrink.

Moving down the P&L, SG&A expense was 27.3% of sales for the quarter, an increase of 30 basis points from the first quarter last year. This was driven by a planned increase in advertising, higher utility costs, and increased fees for debit and credit cards resulting from our recent rollout of Visa credit cards and continued growth and penetration of debit cards in our overall sales mix.

Depreciation and amortization was $41.8 million, unchanged from last as a rate of sales. We continue to expect depreciation of $160 to $165 million for the year, which, as a rate of sales, should be down about 20 to 30 basis points.

Our operating margin for the quarter was 6.6%, a 20 basis point improvement compared to the first quarter last year.

The tax rate for the quarter was 36% versus 37.2% in last year's first quarter. The decrease is due to the recognition of certain tax benefits in accordance with FIN 48, which offset a reduction in tax-exempt interest income. The lower rate resulted in a benefit of approximately $0.01 compared to last year.

Looking at the balance sheet and statement of cash flow, our cash balance approximated $84 million at the end of the first quarter of 2008 versus $189 million of cash and investments at the same point last year. We ended last year with $80 million of cash and investments reflecting more than $473 million of share repurchases in 2007 and no increase in long-term debt. As Bob said, we decided to conserve cash in the first quarter of 2008 rather than buyback stock.

Capital expenditures were $32.7 million in the first quarter 2008 versus $39.7 million in the first quarter last year. The majority of capital expenditures this year were for new stores, remodeled and relocated stores, and the addition of frozen and refrigerated product to 84 stores.

We continue to expect capital expenditures to be in the range of $155 to $165 million for fiscal 2008 and to be focused on the aforementioned store-related projects.

Our inventory grew by 2.8% on a per-store basis in the first quarter compared with the prior year period. This is principally due to planned increases in inventory to support second quarter promotions as well as increases in inventory to meet the stronger demand for basic consumable products. Inventory turns in the first quarter were unchanged from last year, and we would expect them to increase slightly for the full year.

Now to sales and earnings guidance. As we look to the remainder of 2008, we should be mindful of a couple of issues. First, we still face an uncertain economy with many pressures on the consumer. Fuel and energy prices are at an alltime high and rising. We anticipate this will impact our freight and utilities cost and may also dampen customer activity in future periods. In addition, the retail calendar is unfavorable for the latter part of the year as Thanksgiving is a week later than last year, resulting in one fewer weekend than the traditional holiday shopping season.

In this environment we expect gross margin to be impacted by two factors. First, while we are seeing improved merchandise margins within product categories, as a result of the pressure on consumers from this economic environment, we anticipate the basic needs-based categories to grow at a faster rate. While faster turning, these categories are lower margin, and the increased share of sales will put pressure on our overall gross margin.

Second, diesel fuel prices are high and continue to rise. Our guidance includes freight costs continuing to increase as a percent of sales.

From an SG&A standpoint, energy prices and utilities will most likely be higher for the remainder of the year. Otherwise, we expect to hold the line on expenses throughout the year.

With all of this in mind, for the second quarter we are forecasting sales in the range of $1.045 billion to $1.075 billion and diluted earnings per share in the range of $0.33 to $0.36. This implies a low single digit increase in comparable store sales.

For the full fiscal year 2008 we estimate sales will be in the range of $4.52 to $4.63 billion based on approximately 8% to 9% square footage growth and a low single digit increase in comparable store sales. Based on these sales estimates, we are forecasting diluted earnings per share in the range of $2.23 to $2.39, reflecting an increase of $0.06 and $0.04 in diluted earnings per share above the low and high end of the previous guidance for the year and including no impact from potential share repurchase activity in 2008. We currently have about 90 million shares outstanding.

With that, I will turn the call back over to Bob.

Bob Sasser

Thanks, Katy. Before I turn the call over to you all for questions, I want to leave you with just a few summary observations.

For the first quarter we're on track to accomplish our goals. Our sales increased nearly 8% and earnings per share were up 26%. Our gross margin improved by 50 basis points and operating margin increased by 20 basis points. Our investments in infrastructure continue to translate into better inventory management, more efficient stores, improved in stock position and better execution of our model, and most importantly, a better overall shopping experience for our customers.

However, as we all know, fuel and energy prices are high and they continue to rise. In the first quarter of 2007, diesel fuel averaged $2.66 per gallon versus $3.78 on average in the first quarter of this year. That's over $1 higher. Since then, since the end of first quarter, we're already nearly an additional $1 higher at $4.72 a gallon.

We've been able to mitigate much of the increase in past quarters through improved operating efficiencies, better trailer utilization and better routing, which has reduced some miles. But now, with diesel prices $2 above where they were this time last year, there's little doubt that our freight costs will be impacted for the remainder of the year and possibly beyond if diesel prices continue to rise.

We've incorporated this into our guidance. In addition, we do not know exactly how the consumer will react to higher gasoline prices. We do know that they will find no better place to stretch their dollars than at Dollar Tree. In this environment, Dollar Tree values are more appreciated than ever.

Our new Deals concept is progressing and it's exciting. We're opening new stores in new markets. Customer acceptance is strong.

We continue to demonstrate the ability to self-fund the growth of our business while generating substantial free cash and we're dedicated to building value for our long-term shareholders. This means running the business as effectively as possible and managing our capital in a way that enhances shareholder return.

Looking to the second quarter, record high fuel prices, declining home values and tighter credit are putting pressure on family budgets at all income levels. To succeed in this environment, we have to provide our customers with great value for their dollar and a selection that meets their needs as well as their wants.

I believe that Dollar Tree is consumer relevant for these times. Our stores are well positioned with a great seasonal presentation. Our merchandise value and our increased mix of consumer basics differentiates us now more than ever, and it's all just $1. We're off to a good start in the second quarter with the launch of our everything you need for great summer promotion last week, and we are excited about our business.

We are now ready for your questions. So that we can accommodate as many callers as time permits, we ask that you limit your questions to two.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from Mitchell Kaiser - Piper Jaffray.

Mitchell Kaiser - Piper Jaffray

Bob, maybe you could comment, there's been a lot of commentary on gross margin and particularly cost pressures coming out of Asia, but yet you showed nice gross margin expansion in the quarter. Could you maybe talk about product cost coming out of China and how you might be able to mitigate some of that pressure, if there is some, and then maybe just briefly a comment on kind of where you are in terms of the buying process for the remainder of the year?

Bob Sasser

We import about 40% of our product from foreign - mostly China. We've always been able to manage our merchandise margins very well. There's always pressure. There is pressure now on costs on products from China with the exchange rate and just with the general business conditions in China already.

But we continue to grow in size and scale, and our larger buying power continues to translate into lower costs. In first quarter our merchandise margins were higher than last year. Margin at Dollar Tree is really all about the mix of product and not so much driven by the individual item cost. And that is a different way of doing business than others may do. Our model is really very flexible. We're not locked into a specific item. We don't have to have anything. No planograms gives us flexibility to move quickly from one item to the next. And frankly, from China we like moving from one item to the next. We like bringing new products in, things that the customers haven't seen.

So we're in control of that 40% of our mix. We shop the market. We find the best value for the customer at the price that fits within our margin, and we're able to bring tremendous values to our customers because of the focus at the $1 price point.

As we go forward, and you heard me talk about pressures but on the merchandise cost side we're able to manage that. I feel confident that we're going to continue to be able to manage that. That doesn't mean that we may not drop an item, add an item, change an item, things we've done for 20 some years. We'll continue to do that.

But the pressures on margin as we go forward really center around two things. One is diesel cost. Diesel fuel is high, and it's $2 higher now than it was this time last year. As we go forward, is it going to go down? I don't know. So we're forecasting that it's going to remain high. But we know there's pressure on our margin from diesel fuel.

The other thing is the mix. You know, there's a good news item here. We are very relevant with our new larger stores with the consumer products that we sell. There's the time to sell people things they want, and that's all that seasonal and party and all that, but then we now also have things they need and only at $1. And our traffic is up, and it was up pretty substantially in first quarter. So more and more people are finding us now. They're coming to us. That's the good news.

The other side of that coin is they're buying a lot more consumer products now, so the mix, while my markup and my merchandise margin by category is at or maybe even above historical levels, if they're buying more of the faster turning lower margin stuff, that is going to affect our mix going forward. I see that as an opportunity to attract more customers, drive the top line, continue to get leverage on our fixed costs. So it's not a bad thing. It's just a phenomenon as we go forward.

Operator

Your next question comes from Adrianne Shapira - Goldman Sachs.

Adrianne Shapira - Goldman Sachs

Bob, could you just talk about, you know, you've done a very good job on the marketing front, can you talk about what plans you have in place in light of the checks hitting home, how you're looking to grab a greater share of that spend?

Bob Sasser

You know, Adrianne, a lot of our customers are getting those checks, and we hope that they'll come and spend some of it at Dollar Tree. We have promotional campaigns in place in the stores that include window banners and signing in the store and "Stretch your dollar here" and we're really talking it up with the consumers. Go into our stores; you'll see the marketing campaign around that.

You'll soon see one that says, "Look what $20 will buy." That's 20 items, by the way, and there's a picture of a pile of 20 items and it covers the whole banner. So we really are hoping that we'll get our share, and we think we will get our share of those stimulus checks.

We looked back, tried to find some history of this, and it was really hard to look because this is the biggest one ever. But in the past, we have seen some evidence, when there was a stimulus program, that we did get our share of that.

I think we're getting some now, actually.

Operator

Your next question comes from Karen Short - Friedman, Billings, Ramsey & Co.

Karen Short - Friedman, Billings, Ramsey & Co.

I'm just curious. I know you just talked about the shift, a little bit more of a mix shift to the consumables, and I know in the past I think you've commented that basic consumables were 8% to 9% of the mix. Can you just maybe discuss what that percent is currently and whether or not you see that being a risk to your margin just given what inflation is doing in the basic household consumable area?

Bob Sasser

The basic consumable part of the mix - and I'm talking about food and candy and household consumables and those kinds of things - what I've said in the past is that's about 40% of our business. First quarter, that was about 1.4% higher than it was first quarter last year, so not a dramatic effect there.

And the shift that we're seeing is not a shift in the product offering. It's that our customers need it now. They're coming to us for it because it's only $1. So we're attracting new customers, and they're coming for these kinds of things.

A day doesn't go by that I don't get somebody sending me a newspaper article or a TV - where they heard about recipes that you can buy at your local Dollar Tree, buy the ingredients for only $1 and how to stretch your dollars and the whole dollar sector really is getting some good press about that.

We're not expanding our consumer mix in the store, the space to it, but it certainly is something that our customers are looking for now from us, and they're buying more. We're gaining more customers from it. There's times when you can sell them their wants, and there's times you've got to sell them their needs. And right now it's needs based. They're under pressure at the gas pump. Got less jingle in their pocket, and we're right for the times. We're there for them.

Operator

Your next question comes from Meredith Adler - Lehman Brothers.

Meredith Adler - Lehman Brothers

If you could talk a little bit about your plans for share repurchases for the rest of the year? I mean, I know you don't have anything [said] specifically, but is there any reason you wouldn't buy shares? What would be an obstacle to buy?

Bob Sasser

Well, Meredith, we still have the authorization out there, over $450 million. We've never announced that we're going to buy shares. We've always done it opportunistically and reported on it basically after the fact.

So it's still there. It's an option for us. I will tell you that we took a position first quarter because we exceeded all expectations - we bought $470-some million worth last year, which is more than our free cash flow last year, by the way - on buying back our shares. We ended up the year, began this year, with about $80 million in cash on our balance sheet. Still a nice number; everything's fine. But it was a little less than we historically had begun the year with. And as I looked out in the future and I see a lot of these uncertain times, I felt like it was a good time to conserve cash throughout the first quarter.

As we go forward, we'll continue to assess the opportunities. We'll continue to assess the share repurchase, how it fits into our go forward plan. But we're going to manage our balance sheet responsibly, I guess, in these uncertain times. And that's the position that we took first quarter.

We'll report on at the end of the quarter what we do.

Meredith Adler - Lehman Brothers

You have talked in the past of a cannibalization of Deals or that you're looking at it closely, and I was just wondering if you have any updates for us?

Bob Sasser

I really don't, Meredith. The new stores and the new markets have exceeded the performance of the original stores that we bought in the existing markets.

What I do know is some of the stores that we bought were in the same shopping center or across the street. That's too close.

So going forward we're looking for some spread in the two stores because we do better when they're a couple miles apart anyway. But I really can't scientifically give you any data on that. It's more of we knew when to go into these new markets and into opening up new Deals stores on Dollar Trees. So it's something we're going to have to  you're just going to have to wait and we're going to learn as time goes by.

Operator

Your next question comes from David Mann - Johnson Rice & Company.

David Mann - Johnson Rice & Company

If I could ask, on gross margin, you didn't talk about occupancy. Can you give a sense on how occupancy expense performed in gross margin, what your outlook is for the rest of the year?

Bob Sasser

Going into second quarter there may be a little pressure on occupancy. That's in our guidance. We have a little pressure on occupancy going into the second quarter.

And first quarter, we actually had some pretty good results, but we also had some true ups in one of our accrual accounts in the first quarter that was a positive effect to our occupancy costs. It had to do with accrual of our percentage rent that we trued up.

David Mann - Johnson Rice & Company

And how impactful was that accrual?

Bob Sasser

That was in the first quarter, maybe $0.01, something like that. Right, Katy?

Katy Mallas

Yes, about $0.01.

Bob Sasser

But going forward, I know that in our guidance we implied - implicit in our guidance, part of our guidance is a little pressure in the second quarter on occupancy.

David Mann - Johnson Rice & Company

And then if you could talk a little bit about the multi price point tests you have in the Dollar Tree stores, the [oops].

Bob Sasser

The oops, yes, it's there. It's something that we continue to do in 20-some stores, in our Dollar Tree stores.

Just for everybody's edification, we've gone into - get my notes here - we've got 29 stores in the test, and we went in and we put in things that are more than $1, $5 or less, but more than $1, a mix of products. It could be closeouts, special purchases, extreme value items, or things just in some larger sizes, where people like to buy bundle packs of toilet paper and paper towels; we put in some bundle packs. And our signing is "Oops, we know it's not $1 but the value was too good to pass up, so we're passing the value on to you."

The result so far, we've ran about - recently sales in the first [quarter] ran about 1% of total store sales. It hasn't been something so far that we've declared victory and are going to roll out to lots more stores, but we are still aggressively merchandising it, testing it, and working in these markets with doing some new things.

One of the things we're going to be doing in one of the markets soon is adding gallon milk, and it's not  gallon milk and eggs, for example. You know, you can't sell a gallon of milk for $1 but you can for $4 or $4.50, depending on the market price. So as a matter of convenience for our customer, because gas is expensive and we know our customers need milk, so why go anywhere else and burn your gas, buy it here. We know it's not $1 but we have the milk and the eggs for you convenience, dozens of eggs.

So we're testing lots of new things, David. We've got some limited success with an item here, an item there, but overall it has not been something that has been worthy of a major rollout.

Everybody loves it when everything's $1. There's something about the store where everything's $1. It's not everything except this. It's $1. And right now we are getting terrific response, even more than ever. New customers that never shopped with us before. That's anecdotal. I can't prove that. But people that ordinarily would have gone to other locations, other types of venues, are coming to Dollar Tree now, and they love the fact that we're $1.

That doesn’t mean we won't keep trying and testing new things, but so far it has not been an overwhelming success.

Operator

Your next question comes from Michael Baker - Deutsche Bank Securities.

Michael Baker - Deutsche Bank Securities

So two questions here. One, your inventory per foot or per store is up a little bit and you gave the reason for that. It's the first quarter in awhile that we've seen that, so is that a change in strategy that you could elaborate on?

And then my second question, some of the gross margin pressures that you talked about maybe impacting you in the second quarter, the mix, the fuel costs, etc., I imagine those were prevalent in the first quarter as well, yet you clearly had a very strong gross margin. I'm wondering if you think they're going to be worse for some reason in the second quarter than they were in the first quarter, which seems to be implied by your guidance.

Bob Sasser

The one about inventory, the inventory increase was a snapshot in time, up 2.8% per store. It's not a shift in strategy. It was more intended to - after the early Easter, we really went after business. PreEaster was Valentine's. We went after the Easter business, and we went aggressively after the business immediately following Easter and into early second quarter. So that's what you're seeing there is some of the promotions that we had put in. They have been very successful, by the way.

Our turns in the first quarter were equal to last year, no decrease, and we still anticipate and expect to have an improvement in turns for the year. So no strategy change. We're still on the case with our inventory turns, and it's really a matter of balancing the sales and the inventory and the flow of product as much as anything there. We're excited about the improvements that we've made.

In talking about the gross margin, implied, yes, we did have pressures on gross margin in the first quarter, but we were able to overcome it mainly for a couple of reasons. We had improved merchandise mark on in the first quarter, so inflation was not the bogey that you thought it might be. We had some improvement in our shrink in the first quarter. We haven't taken all the credit for that, but our shrink is improving, so that's a good news item in the margin line.

As we go and look into second quarter, fuel prices were $1 higher in the first quarter than last year. They're already looking like $2 higher a gallon than last year. And what you're seeing in our guidance on pressure on the gross margin, yes, I really don't know what it's going to be. It's all about diesel fuel. It's all about how the mix of product, how the customers respond to the mix of product.

So the guidance implies the uncertainty over diesel fuel. If you look at the U.S. government's estimate, they are forecasting that the price of diesel's going to start going down, but I didn't feel like putting that in the guidance. So I'm telling you there's uncertainty on diesel fuel, there's uncertainty on energy costs, and that's going to put pressure on our gross margin.

There's not much uncertainty on our price of goods, though. We're able to buy the product that customers need, offer the great values, and we're able to get the costs - so far, our merchants are doing a terrific job and actually improving the merchandise mark on.

It's a prudent - one last thing, Mike - I think it's prudent to be conservative in uncertain times, and that's what you're hearing from us is the uncertainty over energy and fuel and diesel fuel. And also the impact that that may have on the customers at some point, with high gasoline prices. Right now they're coming to us because they're spending more on gasoline. They need us. At some point, you may run out of gas coming to Dollar Tree. So there's pressure on the customer.

Operator

Your next question comes from Patrick Mckeever - Mkm Partners LLC.

Patrick Mckeever - Mkm Partners LLC

A similar kind of question, but my question is more on the distribution and transportation side. You've talked in the past about how higher fuel costs impact distribution and transportation costs by quarter and said that some quarters it hurts more than others just given the cadence of your shipping and the holidays and so forth. Which quarter would it have the biggest impact on? Is the first quarter where there would naturally be less of an impact as a percent of sales and second quarter, third quarter greater because of the volume going into the holidays, that kind of thing?

Bob Sasser

Patrick, I think the key here is the fact that the diesel fuel prices are high and they continue to rise. So what you saw reflected in fourth quarter, they were higher in first quarter and they're still rising as we go into second quarter.

So you'll see more impact on the high prices sort of after the fact because we actually buy the goods, transport it, put it in the DCs, then put it in the store over a period of, I don't know, weeks. So there's a little lag, I guess, before you actually see that show up in your gross margin. That's one thing.

But I think the real bully in the room here is the fact that it just keeps going up. And at some point it's got to go  I think it will go down at some point. Our forecast, our guidance, assumes, though, that it's not going to go down. We've picked the number, we've spread it out to the rest of the year, and that's kind of where we've guided you to. So it's in our guidance.

Operator

(Operator Instructions) Your next question comes from Charles Grom - J.P. Morgan.

Charles Grom - J.P. Morgan

Bob, regarding your ability to better navigate price inflation, clearly, your ability to rotate skews is a big factor and the lack of strict in-store planograms is a factor as well. And I'm wondering if you could help us quantify that to some extent and, in that matter, could you share with us how many skews that you had in the store on average in the first quarter were held over from a year ago or conversely how many were rotated out?

And then separately, could you share with us the average ticket in the Deals stores? I believe a year ago it was around $16.36. I was wondering what it was this year.

Bob Sasser

Chuck, the average ticket - I'll go with that one first; let me look that up - the average ticket grew slightly, overall, $8.57. Top store average ticket grew $8.57 to $8.60. The new market average ticket was $9.75. I think what you're referring to is our average ticket when we had something in the basket that was over $1, and that was, this year, in first quarter, the original markets were $15.45. The new markets were $16.14. So that's the average ticket with something more than $1 in the basket.

The first quarter was in regard to skew count. Let me give you a little color on it. I don't know that I can quantify it as much as just tell you how we go to market. We'll have 5,000 to 7,000 skews at anytime in our stores. We import probably 40% of our product. Of that 40%, a lot of that's seasonal product, and I would say probably half of that is new product, year to year, season to season. Because of the nature of our customer desires and what we stand for, we like to show a new product. The first year you have it, it sells really good, the second year's usually not quite as good, and you really ought to be changing it by the third year. So that's kind of the way we look at our seasonal and our imports, and it's that ever-changing component of fresh product.

Now having said that, we have a margin plan and a sales plan by department, by category.

So when we are in Asia and we're negotiating our plan for a category, we know what we did last year, we know what we sold, we know what our plans are next year, if we're going to add a skew or drop a skew. We kind of go in knowing what our plans are there. They go through the negotiation process; they may be able to get what their goals are on a new item, something that they went with a goal of I'm going to have a whatever, widget, this year that's going to be terrific, and they may be able to get it, or they may not. Or on something where they've - it's the second year, maybe, and they want to continue to have it; if they can get the price right they'll buy it and if not, they won't, they'll replace that with something.

So that at the end of the trip, they've basically built their assortment, they've put down their commitments, they know the cost and they know what their margin is and they know what their margin target was. And we know when we made the buy what our margin - is it going to be up or down or flat.

That is done depending on the category up to a year in advance, some of it. Somebody asked earlier  I may have not answered it - but where we'd bought out through. Obviously, we've bought pretty much our imports for the remainder of the year. Not that we've stopped buying, but the big chunks are bought all the way through Christmas, so that's already been done and negotiated and in the bag, so to speak, so we know what that's going to be.

But our model has always been to be very flexible. We don't have to have anything. Our contract with our customer is value, and if we can offer them value at the $1 price point, that's our goal. And then we've got to do it at a margin that fits into our plans because we're very proud of making money. I think our margin is the highest in our sector, maybe amongst the highest in retailing.

So as I looked at selling a little more consumer products, I really looked at that as a plus to us to bring in more customers. It's a little lower margin right now, but it's still good margin and it's what people need. I believe that over the period of these kinds of times, we're actually going to increase our market share.

Look back at our history, too. We've always been able to manage our margin in a very tight band, for 20some years, and we are still doing it. First quarter I know was tough out there, and there's people, "Oh, my gosh, inflation." I hear all that.

The end result is, though, our merchandise margin first quarter was higher than it was last year and our sales were up.

Operator

Your next question comes from Joe Feldman - Telsey Advisory.

Joe Feldman - Telsey Advisory

Bob, earlier in the call you mentioned that you feel like you're attracting more customers, and I was curious as to what's driving that beyond, obviously, the type of product, but are you seeing a trade down or do you think it's market share gains against your competitors or, you know, where is that exactly coming from?

Bob Sasser

I think it's more of a trade down, as much as anything. We're more relevant than ever, and we give them every reason to trade down. We're offering great stuff at only $1. We have a real estate strategy that puts our stores  we try to put it in Middle America, where they shop or live. We try to offer a nice shopping experience. That's one thing that we pay a little more attention to than I think maybe some others, but we believe that the shopping experience is something that sets us apart, with bright, clean, friendly stores.

And now we've got an expanded mix in our stores that has happened over the past few years, actually, with more of the things that people need every day, with the frozen and refrigerated and the food and the HBC and all those kinds of things.

So I think people are trading down, and I think they're trying us because they're under pressure at the gas pumps. I don't know if, you know, it cost you probably $60 to fill up a car these days. That was a lot less last year, so you've got $20 to $30 less than you had this time last year after leaving the gas pump.

So I think people are trying us. They're under pressure. Let's try this Dollar Tree store. And when they try us, they're obviously liking a lot of what they see because it's showing up in the sales of some of these - all the products, really, but the consumer products are growing faster than any other part of our business.

Joe Feldman - Telsey Advisory

And just one quick follow up on a separate topic. You mentioned the new store productivity at the Deals has been very good, and I was just wondering if you could comment on the core Dollar Tree stores, if you're still getting the strong productivity that you typically get from a new store?

Bob Sasser

First quarter productivity was up over last year, and I say that with a - I sort of hold my breath because first quarter's a dangerous time to be forecasting success over the full year because you just don't have quite enough stores yet to do that.

The facts are that our stores that we opened first quarter, the productivity in those stores are ahead of last year and ahead of our plan right now. We'll just tell you, it's early. I'm committed to this. We're going to improve the productivity of those new stores, but I'll share with you at the end of the year after we've done it more than at the first of the year when we've just begun.

Operator

Your next question comes from John Zolidis - Buckingham Research.

John Zolidis - Buckingham Research

I was wondering if you could contrast the first quarter sales performance, which exceeded your expectations, with the fourth quarter sales performance, which fell a bit short. What would you attribute the difference in trend? Is it macro, is it merchandising, is it some other factor? And then what gives you confidence that you can continue to perform in line with the results in the first quarter and we won't see kind of a step backwards relative to the improvements that you just reported?

Bob Sasser

That's a good question. That's a tough one, and I can only tell you what I think about it.

The fourth quarter last year, it seems as if we were cruising along, if you remember, in that 4% comp range and all of a sudden fourth quarter came and us and everybody else, it seemed as if you hit a wall. And I believe that it was the sudden surge in some of these macro issues that started creating that uncertainty in our customers' mind.

And, you know, they shopped late. It was a late season, and by the time they came out, they really came out in droves. But there just really wasn't enough - I wish I had another day or two, right? I mean, there just wasn't enough time left from that.

Since they I believe that the pressure has risen, the pressure has continued, but I do believe there's a psyche, a consumer psyche there that says it's not as much of a surprise now. I've got to figure out how to make do with my $60 gas tank. I've got to figure out how to redo my budget. I've got to work it in somehow. And, by the way, I think they're looking for alternatives, and I think that's one of the things that is putting more people into a Dollar Tree store, as I said earlier. So I think that's really kind of what's going on out there with the customer.

What gives me confidence is that I believe that we really are relevant for these times. We run stores with a little shopping experience, we're a little different, we've got fun and exciting things that we've always sold with things that they want in the party and the seasons and the color and the ever-changing mix. And then we also have things to eat and we have dental supplies and household cleaning supplies and all the things you need, and it's only $1. So they're coming in, I think, and they're finding us. They're liking the value, and I think they're going to keep coming back to us for that.

It's up to us. We have to run good stores. We have to set high standards, great merchandise values. As long as we stay true to that, I think good things are going to be coming from these new customers.

But I can't tell you why it stopped in October, November, and I can't tell you why it seems to have accelerated other than I just think it's a consumer psyche of when things are abrupt, they respond by stopping, and then they start trying to figure out how to work it into their budgets. And we're in the right place.

I'd take my lot over a lot of the higher end wants-based retailers, by the way. I kind of like our position today.

Operator

Your last question comes from William Keller - Ftn Midwest Securities Corp.

William Keller - Ftn Midwest Securities Corp.

Just looking at the uses of cash and you mentioned share buybacks; you did not do any in the first quarter. Is that your preferred use of cash going forward or do you have some other things perhaps in mind should you decide to be a little less conservative with the cash balance.

Katy Mallas

You know, at this point it's really all about choices. And given the share repurchase activity we did last year and the economic environment that we're in today, we're still growing our business and so we prefer to use our money and put it back in the business so you'll see Capex in line with where you've seen it in the past and using a lot of our money to put back into the business to open new stores, relocate stores, install freezers, all of those sorts of things. It's really a choice at this point what to do with it.

Operator

And at this time, I'd like to turn the conference back over to Mr. Reid for any additional or closing remarks.

Tim Reid

Okay. Thank you all very much for participating in the conference call today. Thanks, Cindy, for monitoring it for us.

Our next conference call is scheduled for August 27, 2008, when we will discuss second quarter results. Thank you, again.

Operator

Thank you. That does conclude today's conference. You may disconnect at this time.

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Source: Dollar Tree, Inc. F1Q08 (Qtr End 5/3/08) Earnings Call Transcript
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